A cease-and-desist order was issued late last month against Peterson, a former district manager in the circulation department at The Seattle Times who co-founded the biometric security company in 1997.

Peterson's continued violations of securities laws "constitute a threat to the investing public," the order says. It goes on to allege that Peterson sold $50,000 worth of his ABI stock and $600,000 worth of personal promissory notes without giving investors significant information about the risks associated with the deal. He is not registered to sell securities in the state, the order says.

Peterson, who is facing a $50,000 fine, has requested a hearing on the matter. Though Peterson admits to selling some stock to sophisticated investors, friends and family -- including his father and uncle -- he said the stock sales stopped "several years ago" when his attorney told him it was inappropriate. The state alleges that the stock sales continued through last year and that the notes were sold during 2001 and this year.

Peterson declined to comment on the note sales, saying only that he "would never think to do those ever again in my life, and I would not advise anyone to do them."

He said he never intended to defraud anyone.

"I was just a regular guy when my partner and I started this company," Peterson said. "The laws are so convoluted on this you really can't tell. The attorney will tell you do one thing and it is still wrong. And if you do the other thing, you are still wrong. ..."

The Department of Financial Institutions began investigating Peterson in October after receiving a call from a member of the Spokane Police Department who was considering investing. The agency continues to investigate others at the company, said Deborah Bortner, director of the securities division at the department

ABI is developing a palm-scanning device, according to the company's Web site, that uses infrared scanners to take a digital picture of the inside of a person's hand. That picture is then compared with a stored image and used to either allow or deny entry to buildings.

Peterson and his business partner, John Stiver, said they developed the technology over the past 15 years, inspired by the way a flashlight illuminates veins in the hand and investigating ways to childproof handguns. Neither graduated from college, though both are self-described "idea guys" and "inventors."

Over the past couple of years, the privately held company attracted several prominent investors and board members, including former Microsoft Corp. President Michael Hallman, former CIA Director Robert Gates and Raisbeck Engineering Chief Executive James Raisbeck. But in the past year, things started to unravel at the company, according to investors and former employees. Hallman and Gates resigned last fall.

Meanwhile, the company struggled to raise money. And its main product -- dubbed ChronoLog -- was pulled off the market because CEO James Katzaroff said he was not satisfied with its performance or design.

In addition to the cease-and-desist order against Peterson, a lawsuit was filed last month against the company by more than a dozen current and former employees who allege they have not been paid for months.

A countersuit filed this month by ABI in U.S. District Court in Tacoma, says many of those suing for back wages never were employed at the company. It goes on to allege that former chief technology officer Stephen Fishburn -- lead plaintiff in the employee lawsuit -- destroyed and removed assets from ABI, interfered with contractual relationships, did not make good on an investment and initiated a "scorched earth" campaign against ABI in the media that damaged the company.

Fishburn says ABI's case is full of legal errors, false statements and "nonsense."

Ken Hatch, an ABI investor, board member and former KIRO-TV executive, says the situation is "messy."

The board will discuss the cease-and-desist order against Peterson at its next meeting and take appropriate action, board members said.

Katzaroff, reached on his cell phone in New York, said that meeting has not been set and is subject to his travel schedule. He declined further comment on the order, saying it is "an issue for the board of directors." He said the legal dispute with employees is headed to trial.

Hatch and Katzaroff think ABI can rebound once a merger is completed with Vancouver, B.C.-based Electronic Identification Inc. next month. That would create a new publicly traded entity under the name of Advanced Biometric Technologies Corp., Katzaroff said. The merger would bring about $1.7 million in cash to the combined company, he said. ABI executives have promised to pay employees once the deal is consummated.

Despite the legal troubles, ABI continues to operate with about a dozen employees. Katzaroff -- a former ABI consultant who was named CEO in December -- said the company is in good shape.

"We are dramatically overjoyed with the breakthroughs we are having," said Katzaroff, who would not elaborate on the breakthroughs or when the company might release products. "I am very pleased with where we are going."

Hatch, who has a substantial amount of money invested in ABI, said even though the company ran out of money last summer, he believes in the management and "the remarkable nature of the patent."

But not all investors are happy with the company's prospects. Carl Jones, ABI's former chief privacy officer and a current shareholder, said the upcoming merger with Electronic Identification will not solve the company's problems.

"The challenge I feel is that they are merging with a Nevada corporation, with headquarters in British Columbia that is a penny stock traded on the over-the-counter bulletin board," Jones said.

"That doesn't sound like an exciting merger to me, and as a shareholder, it doesn't make tremendous sense."

Jones, who was laid off last year and was sued by ABI for violating a non-disclosure agreement, said the merger will not solve the legal entanglements the company faces. Jones has a countersuit pending in Pierce County Superior Court, with a trial date set for this summer.